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Testing economic evolution
The Vietnamese economy’s performance in the first quarter of 2009 has been heavily struck by the wide-spread global recession.
Turnovers of several key export items, excluding rice, and foreign direct investment disbursement have suffered sharp declines by 20 to 75 per cent. The impacts of local counter-cyclical policies initiated in late 2008 have materialised slightly.
Gross domestic product (GDP) growth in the first quarter of 2009 has fallen to a decade-low of 3.1 per cent on a yearly basis. Annual inflation eased to 11.6 per cent with the consumer price index flattened during monthly terms. Against the backdrop of uncertainty and its implication on the major external drivers of the Vietnamese economy, the stagnant economic performance scenario for 2009 has been recently painted by international private forecasters.
Those pessimistic forecasts, however, may under-estimate the resilience of domestic consumption accounting for 66-67 per cent GDP versus the export contribution of 15-20 per cent on GDP on the value-added basis rather than on a headline and exaggerated 70-80 per cent. The resilience is based on the young and growing population characterised by 40 per cent of total spending on basic consumption.
Though we are cautious on the quick boost of the government’s stimulus package on the economy, the pressing implementation of the stimulus package with the tag price of VND300 trillion, in fiscal and quasi-fiscal investment, VAT relief, personal and corporate income tax and a VND420 trillion in subsidised short-term lending to be extendable within a loosening monetary environment, will likely to off-set substantially the impacts of a steep fall in external drivers in the second half of 2009.
Due to constrained budget revenues by crude, tax rates and an uncertain tax base declines, the stimulus package for 2009’s size is cautiously estimated at 2.7 per cent of GDP, 50 per cent lower than the official figure announced. However, it is sufficiently sizable to generate material effects on the slowing economy.
On the external front, in addition to the nature of exporting income and credit-insensitive consumer staples, it is noted that Vietnam’s exports will also be positively affected from China – the only growing economy among the five largest powerhouses in 2009 – thanks to Vietnamese exports mainly feeding Chinese domestic demand in contrast to other Asian countries’ shipment to China for re-exporting to western economies.
Factoring these together, our forecast on GDP growth is within the 3-4 per cent range in 2009, indicating mounting challenges for a 6.5 per cent target set by the government in the beginning of 2009.
An appropriate move toward a flexible FX rate
Amid mounting challenges for the economy going forward, the State Bank recently announced the widening trading band for the FX market from 3 to 5 per cent, effectively depreciating the dong by 2 per cent at most from the prevailing rate of about VND17,500 per dollar.
This move has been expected for quite some time since the real exchange rate of the dong – a determinant on Vietnam’s export competiveness has been somewhat overvalued due to its quasi-peg to the US dollar since the end of December, 2008. Meanwhile, currencies of major economies, which are major destinations for as well as competitors to Vietnam’s exports, have depreciated relatively against the dollar from September 2008 to February 2009.
The move is considered well-designed though the estimated overall balance of payments (BoP) during 2009’s first quarter has been in surplus due to the steep fall of 40 per cent plus in imports coupled with flat export turnover largely because of strong growth in the exports of rice and gold though the very bearish forecasts on the inflows in the BoP such as remittances, FDI and ODA have been taken.
The trade surplus and overall BoP will be very likely short-lived as it is expected a return to structural trade deficit induced by surging imports associated with the deployment of big industrial projects and gradual improvement in importing inputs for exports in the coming three-six months while financing inflows will continue to shrink sharply through out of the year compared to 2008. Hence, the central bank’s move may show active measures to re-align the FX rate toward a more flexible space which is consistent with the overall objectives of demand of stimulating and improving trade and capital balance positions.
The export supporting and BoP positions will be amplified by the trend of a weakening dollar pushed by the FED’s recent moves in boosting quantitative easing by a $1.1 trillion deal to purchase Treasuries bills and re-financing extended mortgage-backed securities in the coming months.
Given the trade account and BoP surpluses, the State Bank may intervene to stabilise FX fluctuations at least in the short-run. More importantly, the State Bank will likely be able to anchor a roughly 3 per cent depreciating path of local currency from now to the year-end, which appears manageable given expectedly improved position of BoP in 2009 against a large deficit of $4-5 billion in overall balance in 2008.
As a result, there will be room to reduce interest rates on dong deposits without scarifying a required differential (a rough estimate of 4 per cent) to make dong-denominated deposits attractive relatively to dollar-denominated deposits in local market (currently staying at 5 per cent in average) taking into account a 3 per cent expected depreciation of the dong and forecast inflation of 5-7 per cent by the year’s end.
In terms of FX market operations, the move is well-timed to help clear smoothly any demand pressures on dollars given the following factors: - Recently, commercial banks found it difficult to buy and sell dollars to corporate clients since exporters did not want to sell dollars and the importers did want to buy dollars rather than borrow for their business due to widely-expected depreciation.
- Given the mounting demand pressure, commercial banks attempted to utilise FX derivatives to get around the ceiling rates by the central bank to conduct FX transaction at the free market rates. Those practices have been recently harshly restricted by the central bank, suppressing the liquidity of interbank FX market induced by the widely-expected re-alignment
- Recently, the free FX market has not been volatile and dong pressure has stabilised thanks to impacts from the Fed’s move toward more aggressive quantitative easing. On the other side of the coin, the re-alignment of FX has increased costs for imports and debt servicing and debt burden of foreign liabilities by 2 per cent. This negative impact on the cost of imports and debt burden will bring more stringent consideration on imports and external borrowing to optimise the cost and benefit of those businesses in the economy.
In conclusion, the central bank’s widening FX band is a positive move in terms of policy choice and timing to stabilise the FX market, improving the BoP position, providing traction for interest rates reductions to stimulate the economy in an extremely challenging evolution of the global recession.
VietNamNet/VIR
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